IN A NUTSHELL: Do you know whether you belong to a defined benefit (DB) or defined contribution (DC) retirement fund? This matters because it determines how your pension will be calculated and where your income will come from when you retire.
If you belong to a defined benefit (DB) fund such as the Government Employees Pension Fund (GEPF), you’re guaranteed a pension for life. And because the benefit — or pension income — is defined in advance, the fund bears the investment risk, not you.
When you retire, your pension is calculated according to the fund’s rules, usually using a formula based on your final salary and years of service.
In a defined contribution (DC) fund, your accumulated savings at retirement must be used to buy an annuity, which will determine the monthly pension income you receive.
In a defined benefit (DB) fund, you don’t have much control over your pension income. In a defined contribution (DC) fund, however, you carry much more responsibility. When you retire, you must decide how to reinvest your savings and which annuity (income product) to buy. These choices will determine how much income you receive each month for the rest of your life.
Although a few large DB funds still exist in South Africa, most workers now belong to DC funds, which means your retirement income depends on your decisions, not a formula.
It’s a big responsibility — but let’s break it down.
When DC fund members retire, they must invest two-thirds of their retirement savings into another investment vehicle, called an annuity. In general, an annuity pays you a regular income or pension during your retirement. Typically, you can choose between:
- A life annuity
- A living annuity
- A combination of the two, called a blended annuity
Here’s another way of looking at it:
Trustees can empower members by:
- Helping them understand the type of fund they belong to – whether it’s a Defined Benefit (DB) or Defined Contribution (DC) fund – and what that means for their pension at retirement.
- Making sure DC members know that their savings don’t automatically turn into a pension when they retire – they must reinvest their lump sum in an annuity to receive a monthly income.
- Educating members about their choices after retirement, including the different types of annuities (life, living and blended annuities) and how each one affects their income, flexibility and legacy.
Further reading
Five retirement risks — and how to manage them
Sources
Just SA: The four retirement risks and how to manage them
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